LONDON, Sept 28 (Reuters) - The euro fell on Friday to its lowest in nearly two weeks while Italy’s bond yields hit their highest in three after the government agreed to set a higher than expected budget deficit target that could put Rome on a collision course with Brussels.

The Italian government on Thursday targeted a budget deficit of 2.4 percent of gross domestic product (GDP) for the next three years, marking a victory for party chiefs over economy minister Giovanni Tria, an unaffiliated technocrat.

The deficit, though within the prescribed EU limit of 3 percent of GDP, is a concern for investors who fear the country’s anti-establishment government is not committed to tackling its huge debt load. Italy’s debt-to-GDP ratio stands at about 130 percent, the highest in the euro zone behind Greece.

European shares opened lower, with shares in Italian banks - whose big sovereign bond portfolios make them sensitive to political risk - bearing the brunt of selling pressure. The pan-European STOXX 600 index was down 0.3 percent by 0743 GMT.

Italy’s two-year bond yields - the most sensitive to political noise in recent months — were up 31 basis points in early trade at 1.09 percent.

Other Italian yields were also higher on the day, with five-year yields rising 26 bps to 2.16 percent and benchmark 10-year yields up 17 bps at 3.08 percent.

The euro fell to an 11-day low of $1.1615 after suffering its worst one-day decline in seven weeks on Thursday.

“The 2.4 percent target is not consistent with an improvement in the structural budget balance and hence they seem to be on a collision course with Brussels,” said ING strategist Martin van Vliet.

“For me the key issue is what they assume on the budget beyond 2019. They are seemingly leaving the path of fiscal consolidation and that may not sit well with ratings agencies.”

The falls in European shares left MSCI’s All-Country World Index down 0.1 percent and set for its firstly weekly loss since early September.

In Asia earlier, Japan’s Nikkei raced to a 27-year high on the back of a lower yen and improved prospects for corporate earnings.

Japan’s Nikkei stock index rose as high as 24,286.10 points, its strongest since November 1991, on renewed optimism over the global economy and hopes of a boost to exporters’ earnings from a weaker yen. It was last up 1.5 percent.

Shares in China were higher ahead of a week-long national holiday. Blue-chips stocks gained 0.8 percent and the country’s main Shanghai Composite index was up 0.7 percent.

KING DOLLAR

The dollar index, which tracks the U.S. currency against a basket of six major rivals, was up 0.2 percent at 95.086 on Friday. It hit its highest in more than two weeks on Thursday.

After the Federal Reserve raised interest rates on Wednesday - the third increase this year - Fed Chair Jerome Powell said that the United States does not face a large chance of a recession in the next two years and the central bank plans to keep raising rates gradually.

But Citi analysts cautioned that not all data was reassuring.

“The Citi US Economic Surprise Index has been pushed into negative territory by disappointing housing data in the United States,” they wrote.

“The latest data confirms that the housing market continues to be less than ideal. Pending home sales, a leading indicator, declined to the lowest level in seven months.”

U.S. Treasury yields ticked lower. The yield on benchmark 10-year Treasury notes was at 3.0500 percent on Friday, against Thursday’s U.S. close of 3.055 percent.

The two-year yield, closely tied to expectations of higher Fed fund rates, touched 2.8310 percent, compared with a U.S. close of 2.835 percent.

U.S. crude oil gained 0.3 percent to $72.35 a barrel and Brent crude was up 0.3 percent at $81.95.

Gold advanced slightly after tumbling 1 percent on Thursday on strength in the U.S. dollar, which made bullion more expensive for buyers using other currencies.

Spot gold was up 0.14 percent at $1,184.05 an ounce.

Reporting by Ritvik Carvalho
Additional reporting by Abhinav Ramnarayan in London and Andrew
Galbraith in Shanghai
Editing by David Goodman